Monday, August 18, 2014

According to data from the CoStar Group, the commercial real estate market is enjoying very healthy conditions. Prices have been rising at a 10% annualized rate for the past five years. Sales activity was up 14.5% in the first half of this year compared to a year ago, and only 8.7% of properties were selling at distressed prices, the lowest such rate since Q4/08.

It's hard to find anything to complain about here: there's been a robust and ongoing recovery in a market that was severely punished in the Great Recession. This wouldn't be happening if the economy weren't improving. However, the strength of property prices is likely driven at least in part by easy money and low interest rates, and as such could be a "canary in the coal mine" signaling rising inflation pressures. It's certainly hard for the Fed to square this data with the need for extremely low interest rates for the foreseeable future.

Meanwhile, it's a bonanza for investors in commercial real estate: 10% annual price gains plus rental income of 4% or more. That helps explain why the Vanguard REIT ETF (VNQ) has registered a total annualized return of 23% since mid-2009: back then, investors feared that the real estate market would never recover, and consequently many real-estate-related securities were trading at seriously depressed valuations. In any event, should the Fed indeed make an inflationary mistake by keeping interest rates too low for too long, investors should remember that real estate has traditionally been a good hedge against unexpected inflation.

A member of my tennis club is the founder of a large company which owns apartment complexes from Richmond to Charlotte.

I speak with him frequently and his company is feasting on the extremely low interest rates and the rising apartment rents. He said he has always borrowed for large mortgages and his company have never had it so good. He will take all he can borrow at these interest rates.

WSJ Survey Says: Investors Have No Idea How Well the Stock Market Is Doing

"When asked how much the U.S. stock market rose last year, about one-quarter of them guessed it increased by 20% or more, according to a Wells Fargo/Gallup Investor and Retirement Optimism Index poll. The survey, conducted in late June and early July, polled a sample of U.S. investors that had at least $10,000 in stocks, bonds mutual funds or retirement accounts. Some 37% of respondents thought the market rose by 10% last year. Another 21% thought stocks were flat and about 9% believed the market fell last year. In reality, the S&P 500 gained 30% last year and was up 7.2% this year through Tuesday’s close. The Dow Jones Industrial Average rose 27% in 2013 and was up 2.1% on a year-to-date basis.

That’s a far cry from the late 1990s, when day trading dot-com stocks was all the rage and anyone from barbers to taxi drivers would chat about the market’s latest move. There are several reasons investors aren’t euphoric by the market this time around. Investors are still scarred by the financial crisis, which occurred only six years ago. After two boom-and-bust periods over the past 14 years, there appears to be an ingrained skittishness about getting too optimistic about the market no matter how high it goes….

On a yes or no basis, 52% said now was a good time to invest in financial markets, down from 62% at the beginning of 2011, according to the survey.

WSJ: If Secular Stagnation Theory is Wrong, Rate Hikes Will Be Fast and Hard

"Secular stagnation, a theory brought to prominence by former U.S. Treasury Secretary Larry Summers, argues developed economies have entered a period of structurally low growth.

This could be because the returns to innovation have diminished–the internet may be revolutionary, but as a fundamental driver of human potential it’s not a patch on the internal combustion engine, refrigeration or penicillin. It could be that intellectual property laws are acting as a brake on creativity and development. It could be because the ultimate fruits borne by inventions of the past couple of decades won’t be seen for another decade or two. Or maybe it’s down to something else.

Whatever’s behind secular stagnation, low potential growth implies a build-up of savings as investors are left with few sources of good returns. This savings glut, in turn, implies low interest rates.

Many central bankers seem to subscribe to the secular stagnation thesis–or at least its results. For instance, Bank of England Governor Mark Carney has argued that future “normal” trend interest rates will be substantially lower than they were in the past. In the U.K.’s case this would be a rate closer to 2.5% than historic average of around 4% to 5%."